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PokerTek, Inc. (NASDAQ:PTEK)

Q2 2010 Earnings Call Transcript

August 10, 2010 11:00 am ET

Executives

Jody Burfening – IR, Lippert/Heilshorn & Associates

Mark Roberson – CEO, CFO & Treasurer

James Crawford – President & Board Member

Analysts

Mark Smith – Feltl & Company

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2010 PokerTek Inc earnings conference call. My name is Sally, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms Jody Burfening with LHA. Please proceed.

Jody Burfening

Thank you operator, and good morning everyone. Welcome to PokerTek’s investor conference call for the second quarter ended June 30, 2010. The purpose of today’s call is to provide PokerTek’s investors and other interested parties with information about its operating results and to communicate other business developments.

Joining us from management are Mark Roberson, Chief Executive Officer and Chief Financial Officer; and James Crawford, President and Founder.

Before we begin, I will read the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. The statements that are about to be made in this conference call that are not historical facts are forward-looking statements, and involve risks and uncertainties. These and other risks and uncertainties are described in more detail on the company’s most recent Annual Report on Form 10-K and other reports filed with the Securities and Exchange Commission.

The company expressly disclaims any obligation to update or revise publicly any forward-looking statements whether as a result of new information, future events, or otherwise. The company will also discuss EBITDA, which is a non-GAAP measure used internally to evaluate performance and allocate resources. The manner in which the company uses EBITDA may differ from the manner in which other companies use the term EBITDA or EBITDAS.

On today’s call, the company will also discuss its operating results in a pro forma basis as if the amusement business had been treated as a discontinued operation for GAAP purposes as of June 30, 2010.

With that introduction, I will now turn the call over to Mark Roberson. Go ahead please Mark.

Mark Roberson

Thanks Jody. Welcome everyone and thanks for joining us on today’s call. On our last conference call in May, we discussed the strategic changes being implemented to position PokerTek for profitable growth.

Just to recap, our strategic plan encompasses the following key elements, targeting the right markets to accelerate revenue growth, expanding our product portfolio while lowering our product costs, and controlling expenses. With regard to the stated objective of targeting the right markets, we continue to transition tables from highly saturated traditional gaming market to markets with less competition and where electronic table games excel.

For the second quarter, 90% of our revenues were now derived from installations with limited or no competition. These changes in market mix have resulted in a stronger and more reliable recurring revenue stream, in addition, gross gaming margins increased to 60%, reflecting a combination of improved product performance and lower costs.

As part of our mid-year planning process and in keeping with its key objectives, we took a hard look at our amusement segment and concluded that the Heads-Up Challenge business simply does not fit our long-term vision of becoming a diversified supplier of electronic table games. In addition, the current trends and future prospects for the coin-op industry do not justify continued investment in this line of business.

Our plan is to sell our amusement inventory and related assets over the next two to three quarters as we exit that business. We are reducing prices to adapt to changing market conditions, and to accelerate sales and generate cash flow. These actions will have a favorable impact in future periods driving positive cash flow for investment in the gaming business.

In addition to enhancing cash flow, this allows us to migrate all of our focus to expanding the gaming business where business conditions and growth opportunities are favorable. We will touch on the accounting and reporting applications of discontinuing the amusement segment in a few minutes when we recap the numbers for the quarter.

With regard to the second element of our strategy, expanding our product portfolio with lower cost products, I am happy to report that game development and hardware production are on schedule, and we expected to play BlackJack as the first new game on the ProCore platform later this year. ProCore leverages the same operator and player friendly attributes that have made PokerPro as the dominant Poker product in the industry and will be very competitive from a pricing standpoint.

Before reviewing the numbers for the quarter, James Crawford will provide an update on the current opportunities that we see in the gaming business.

James Crawford

Thanks Mark. Less than a year ago we started our push into Mexico and we took over international distribution in the rest of the world. The efforts being made in those markets during the first half of the year are expected to drive increased inflations for the second half of 2010 and 2011, which will in turn drive increased revenue growth.

In Mexico, we have established PokerPro as the dominant poker table where we now have over 50 tables installed. Having gone head to head with other automated tables across Mexico, PokerPro has consistently won out and displaced competitor’s products. Our current market penetration represent only 25% of the potential for PokerPro in Mexico, that coupled with having contracts with all the major operators provides a significant room for growth in the second half of 2010 and in 2011.

Our new tournament software was installed at our first customer site in (inaudible) and has received very good reviews from both the operator and the players. We also currently announced our participation in Mexico’s first national tournament with Cirsa and PokerStars.net. The Poker market is its infancy in Mexico and we believe that events like the national tournament will serve to increase the popularity of Poker there.

In Europe, we took over distribution in the first quarter and have developed a solid pipeline of opportunity that are working their way through the sales cycle. Just after the end of the quarter, we opened a new eight-table room in Bucharest. Those tables are performing well and we are seeing more interest in PokerPro throughout the region. We are in the advanced stage of the sales and approval cycle with several new jurisdictions and anticipate further placement throughout Europe and Africa in the coming months.

In South America, we see a lot of potential to leverage the relationships with our current operators in Mexico and to expand into their properties further south. We are actively analyzing those markets and engaging in conversations with operators and believe these large markets offer significant potential for 2011.

Since announcing ProCore in late June, we have received a number of inquiries from potential customers, and just recently received our first purchase order. Mark?

Mark Roberson

Thanks James. I trust that everyone has had the opportunity to review this morning’s earnings release that contained the detailed financial results for the quarter. In the earnings release, we presented the financial results on a GAAP reporting basis, which includes results of operations of the amusement business and the related non-recurring charges in operations.

We have also provided the results on a supplemental pro forma basis as if the amusement business has been treated as a discontinued operation as of June 30. Beginning with our September 30 reporting cycle, the amusement business will begin being reflected as a discontinued operation in those financial statements.

For purposes of today’s call, I will refer primarily to the pro forma numbers presenting the amusement business as a discontinued operation as those represent the best indicator of the trends in our continuing gaming business. Total gaming revenue for the quarter was $1.3 million compared to $1.2 million in the prior year. For the first half, gaming revenue was $2.8 million compared to $2.7 million. Overall, gaming revenues were up modestly compared to prior year. Underneath the raw numbers however, there have been significant changes in the market and in the customer mix.

In 2010, the percentage of our gaming revenues derived from highly competitive traditional markets has trended down to 10% as we reduced payables in unfavorable markets, and expanded our penetration in markets where conditions are more favorable. During the first half, we installed 38 tables in our target markets while removing tables from less favorable markets. As a result, the 220 PokerPro tables as of June 30 reflect a revenue base that is more reliable and sustainable providing a solid foundation for growth.

On a sequential basis, gaming revenues actually declined in Q2 from Q1 even as our mix was improving. There are two primary factors that affected the sequential quarter comparison I would like to point out. First, the second quarter is historically the lightest quarter of the year for our cruise ship business and 2010 was no different. The other significant variable was that we had a customer asked to reduce the number of tables in their floor in a highly competitive market and to convert those tables from a least model to a purchase model.

Pursuant to the GAAP accounting rules, we did not recognize any revenue from this customer in the second quarter pending completion of the contractual process. While this negatively affected the reported revenue in the second quarter when customers in highly competitive markets decided to make a long-term purchase commitment, we believe that is a strong indicator of the quality and performance of our product. We expect to complete this transaction soon, which will have a corresponding favorable impact on both earnings and cash flow in the second half of the year.

As the quality of revenue improved in the first half in the second quarter so did our gross margins. Gross profit margins increased from 38% in the second quarter and 44% in the first half of 2009 to stabilizing at 60% for both the quarter and the first half of 2010. On the expense side, we continued to run lean with operating expenses coming in at $1.6 million for the quarter, down from $2 million in the prior year. For the half, operating expenses came in at $3.4 million, down 24% from $4.5 million last year. We implemented significant cost reduction initiatives leading up to the fourth quarter of last year, and our operating expenses have been relatively stable in the $1.6 million to $1.7 million range for the past three quarters.

Bottom line results improved significantly. Net loss from continuing operations for the quarter was $0.9 million or $0.06 per common share compared to $1.7 million or $0.15 per common share last year. For the half, the comparison was $0.12 per share versus a loss of $0.32 last year, an improvement of over 60%. EBITDAS from continuing operations was negative $155,000 for the quarter that compares to a loss of $713,000 a year ago, an improvement of 78%. Cash used in operations improved to $246,000 for the half compared to $1.3 million in the first half of 2009, and again the improvement in cash flow are really a direct result of the improvement in EBITDA performance and tight working capital management.

Overall, we are pleased with our progress in the first half. We are making solid progress on each of the strategic initiatives targeting on the right markets to accelerate growth, expanding our product portfolio and controlling our expenses. Our revenue mix is improving; gross profit margins are up significantly, operating expense is under control. The disposition of the amusement business will generate free cash flow that we will invest in the higher margin gaming business, and we have significant near term and long-term opportunities in Poker and as we expand into other gaming areas.

Looking ahead, we expect the rate of our gaming table installations to increase in our target market, which will drive revenue growth, EBITDA and cash flow for the second half of 2010 and into 2011.

Operator, we are now ready to open the call for any questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from the line of Mark Smith with Feltl & Company. Please proceed.

Mark Smith – Feltl & Company

Hi guys, can you just give us a quick update on your traditional domestic markets including Canada, kind of how many tables are out there and how these operators are doing?

James Crawford

Mark, this is James. The tables that we have in the markets where we are in the United States, I do not have an exact table number in front of me right now for North America but as Mark has said earlier, where we had contracted from really competitive markets, the tables that we have installed are in pretty solid customer bases that are generating good revenue for us. We do have a few tables still and some highly competitive markets that will probably either re-allocate or remove, but Canada continues to be a pretty strong market for us. We are expanding and waiting on really regulatory to help us expand even further into Canada, and I think you will see some good movement there in the second half of the year.

In the US, really, it is a tough market. The traditional markets such as Nevada and Atlantic City, we are just going to have a tough time competing with lot of gaming as we have in the past. I think as the expenses and as the revenues decline in the traditional casinos, they are going to have to look for alternatives to get rid of some of those expenses and I think they are going to start taking a more favorable look at our products. In the past it has been – we do not want to do it because nobody else is doing it, and we do not want to be the odd man out because everybody is just going to migrate the business to somewhere else. I personally believe that that is going to change in the future.

Currently there are still opportunities for us and we do get requests for us to look at different properties to entertain the idea of going in with the partner on a revenue share, but we are taking a very hard look at any of those opportunities. They have to meet a certain requirement both in contractual terms, length of contract that we are willing to go in as far as revenue (inaudible). We have other opportunities outside the US that are giving us better returns. Yes, we could grow table base in North America in traditional US markets, but the return on investment outside of those markets right now is better for us. I am not saying that that is going to remain the same for ever and that there is not opportunity for us but right now that is kind of where it is.

Mark Roberson

You know Mark, just to expand on that a little bit and get in a couple of the numbers too, we have decreased the table count in the North American markets and particularly in the highly competitive markets, there are places certainly in the US and definitely in Canada that are very favorable markets for us that have the characteristics that we are looking for in our target markets of low saturation, low competition and/or operators looking for in highly competitive markets who are really looking for (inaudible) offering of Poker. You know they are not looking for a 20-table room, they will be looking for two or three tables and our product does very well in those sort of environments.

As we have talked about from a table count standpoint, as of the end of Q2, 87 of our 220 tables were in North America, US and Canada. Of the tables that we have in the US and Canada, about 30 of those we would consider still highly competitive markets but those are situations where the tables are doing well in those markets, we have pruned out the low performers, and we are kind of down to a base of 10% of our revenues and 14% of our tables that continue to perform well in the US North American markets, in highly competitive markets within the US market.

James Crawford

Right and one thing I will add is that the Harris Cherokee [ph] the markets were mandated by law, we do extremely well. Harris Cherokee continues to be – you know, it is an outstanding property and then other states that we are mandated or travel properties where it is mandated it is electronic, of course we do extremely well.

Mark Smith – Feltl & Company

And Mark, do you have a number on how many cruise ship tables you have?

Mark Roberson

Yes, at the end of Q2, we had 56 cruise ship tables.

Mark Smith – Feltl & Company

Okay.

Mark Roberson

The breakdown of the 220, 56 on cruise ships, 87 in North America, 55 in Mexico, and 22 international.

Mark Smith – Feltl & Company

Perfect, thank you.

Mark Roberson

Thanks Mark,

Operator

(Operator instructions) This concludes the question-and-answer portion of the call. I will now hand the call back over to Mark Roberson for closing remarks.

Mark Roberson

Thank you. We appreciate everybody’s participation in listening in on the call today, and we look forward speaking to you again with our third quarter results coming up in just a couple of months. Thanks a lot, bye.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.

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